Rise in U.S. inflation puts spotlight on Fed's Powell

By Lucia MutikaniReuters

WASHINGTON (Reuters) - U.S. consumer prices rose more than expected in January as Americans paid more for gasoline, rental accommodation and healthcare, raising pressure on new Federal Reserve chief Jerome Powell to prevent a possible overheating of the economy.

The report from the Labor Department on Wednesday, however, likely overstates the inflation picture given that some of the price gains, especially for apparel and motor vehicle insurance, are seen by economists as unsustainable.

Inflation, which could get a further boost from a tightening labor market and increased government spending, might force the Fed to be more aggressive in raising interest rates this year than currently anticipated. That would slow economic growth.

The U.S. central bank has forecast three rate hikes for this year, with the first increase expected at its next policy meeting in March. Powell took over the reins of the Fed from Janet Yellen earlier this month.

"While we have been looking for inflation to firm, we think last month's increase probably overstates the underlying trend," said Michael Feroli, an economist at JPMorgan in New York.

"Today's inflation reading should probably cement in place the Fed's intent to hike rates at the March meeting. We now also think the odds are moving up that they also revise their guidance at that meeting from looking for three hikes this year to four, aligning with our view."

The Labor Department said its Consumer Price Index increased 0.5 percent last month as households paid more for gasoline, rental accommodation and healthcare. The CPI rose 0.2 percent in December. The year-on-year increase in the CPI was unchanged at 2.1 percent in January as the large price gains from last year dropped out of the calculation.

Excluding the volatile food and energy components, the CPI shot up 0.3 percent. That was the largest increase since January 2017 and followed a 0.2 percent rise in December. The year-on-year rise in the so-called core CPI was unchanged at 1.8 percent in January. Economists had forecast the CPI increasing 0.3 percent in January and the core CPI rising 0.2 percent.

The core CPI is viewed as a better measure of underlying inflation trends. The Fed tracks a different index, the personal consumption expenditures price index excluding food and energy, which has consistently undershot the central bank's 2 percent target since mid-2012.

The dollar <.DXY> initially rose against a basket of currencies after the data but later surrendered the gains. Stocks on Wall Street opened lower before erasing losses. Prices of U.S. Treasuries fell.

U.S. financial markets have been on edge after being spooked by a surge in annual wage growth in January.

INFLATION BUILDING UP

So-called base effects will turn more favorable in March, which economists say would set the course for higher annual inflation readings. Average hourly earnings jumped 2.9 percent on an annual basis in January, the largest rise since June 2009, from 2.7 percent in December.

A pickup in wage growth as the labor market hits full employment is expected to contribute to higher inflation this year. Fiscal stimulus in the form of a $1.5 trillion tax cut package and increased government spending are also expected to add to price pressures.

"The Fed's task is complicated by the recent tax cuts and spending deal, which will stimulate the economy at a time when the labor market is already at, or close to, full employment," said Gus Faucher, chief economist at PNC Financial in Pittsburgh.

A weakening dollar is also expected to put pressure on inflation. Rising inflation could hurt consumer spending, which is already showing signs of slowing. A separate report from the Commerce Department on Wednesday showed retail sales fell 0.3 percent in January, the largest decline since February 2017, after being unchanged in December.

"Bad January weather could have contributed to the weakness in retail sales as consumers avoided auto dealerships and put home building projects on hold," said Scott Anderson, chief economist at Bank of the West in San Francisco.

The weak retail sales and stronger inflation prompted the Atlanta Fed to slash its first-quarter gross domestic product growth estimate by 0.8 percentage point to a 3.2 percent annualized rate. The economy grew at a 2.6 percent pace in the fourth quarter.

Inflation last month was driven by gasoline prices, which rebounded 5.7 percent after falling 0.8 percent in December. Crude oil prices surged in January on strong global demand and a depreciating dollar. Food prices rose 0.2 percent in January.

The core CPI was boosted by rising rents. Owners' equivalent rent of primary residence, which is what a homeowner would pay to rent or receive from renting a home, increased 0.3 percent after a similar gain in December.

There were also increases in the cost of motor vehicle insurance, which recorded its largest gain since November 2001. Prices of personal care products posted their biggest increase in three years. But consumers got some respite from airline fares, which fell for a third straight month in January.

Prices of new motor vehicles slipped last month and the costs of recreation, communication and alcohol were unchanged.